How Do Trusts Help You Save on Taxes?
Many people come to us curious (or confused) about trusts and taxes. So today’s article is going to sort it out and clarify things for you.
There are two major types of trusts, and each has different tax consequences.
INCOME TAXES
Revocable trusts, which are the far more commonly used trusts, have no immediate tax consequences whatsoever. A revocable trust has your social security number as its tax identifier, and is not a separate entity from you for tax purposes. It is a separate entity from you for purposes of probate, meaning if you become incapacitated or die your Trustee can take over without a court order, keeping your family out of court. But, until your death, it’s treated as invisible from a tax perspective. At the time of your death, if your revocable trust provides for the creation of irrevocable trusts, then the tax implications will shift.
When you have an irrevocable trust, either created during life, at death through a revocable living trust, or through a will that creates a trust, that trust has its own EIN, or employer identification number (also called a TIN or taxpayer identification number). Generally, it pays income taxes on income earned by the trust, as if it’s a separate tax paying entity.
Trust income is taxed at the highest tax bracket applicable to individuals as soon as there is over $12,950 of income, so in some cases a trust can be drafted to provide that the tax consequences pass through to the beneficiary and are taxed at his or her rates. We will often do this when creating a Lifetime Asset Protection Trust for a beneficiary, so that the trust can provide the benefits of credit protection from lawsuits, divorce, or even bankruptcy, but not have the negative tax consequence of the highest tax rates on very little income.
Of course, if you have a trust, and you want us to review it for the income tax consequences to your loved ones after your death, please contact us.
ESTATE TAXES
Now, let’s talk about estate taxes. Currently, if you die with assets over $12.92 million, then your estate will be subject to estate tax on all amounts over that $12.92 million at the rate of 40%. Yep, 40% will go to the government. You can mitigate these taxes, or even eliminate them by using various planning methods, most of which are fairly complex, but worth it if you can save your family that 40% estate tax.
The current $12.92 million estate tax exemption is set to expire on Jan. 1, 2026, and return to its previous level of $5 million, which when adjusted for inflation is expected to be around $6.03 million. Not only that, but Democrats in Congress proposed legislation to reduce the estate tax exemption to only $3.5 million while raising the estate tax rate to 45%. This legislation has not yet passed due to lacking only a single vote in the Senate. Here’s one thing we know for sure: We don’t know what the estate tax exemption will be at the time of your death, and we also don’t know what the value of your assets will be at the time of your death. Because of this, when you plan with us, we will ensure that we put in place planning strategies to protect your estate from estate taxes, regardless of the amount of the estate tax exemption or the size of your assets.
One incredibly important estate planning tool in trusts for married couples is how the right plan can preserve the estate tax exemption for the first spouse to die within the trust during the survivor’s lifetime so that it is added to whatever the estate tax exemption is at the time that the second spouse dies. The difference between just $3.5 million and $12.92 + $3.5 million could be considerable for many estates.
CAPITAL GAINS TAXES
Normally, when a person dies and their assets are inherited by their heirs, their heirs will receive a "step-up" in basis. In other words, the value of the assets at the date of the person's death will be the "basis" for purposes of calculating capital gains taxes if the assets are sold by the heirs.
However, when a married couple creates a trust together, it may be possible to obtain a "double stepped-up basis." This would mean that the assets would first receive a step-up in basis when the first spouse dies, and then those assets would receive a second step-up in basis upon the death of the surviving spouse. This can be a substantial cause for savings in taxes, particularly in a case where one spouse will outlive the other spouse by decades.
This is where trusts come into play. Typically, assets in a revocable trust have eligibility to receive a step-up in basis, and assets in an irrevocable trust do not have eligibility for a step-up in basis. But, it is possible to draft your revocable trust in such a way that assets can go into a Marital Share or Marital Trust in order to take advantage of the double step-up in basis for your heirs. If you have any highly appreciated assets, such as your home, this can be a huge tax savings consideration.
If you are trying to figure out whether an irrevocable trust, or a revocable trust or even a Lifetime Asset Protection Trust is best for you and your beneficiaries, our Personal Family Lawyer® can help you weigh that decision and make the right choice for yourself and the people you love.
This article is a service of J.A.A. Purves, Personal Family Lawyer®. We do not just draft documents; we ensure you make informed and empowered decisions about life and death, for yourself and the people you love. That's why we offer a Family Wealth Planning Session™, during which you will get more financially organized than you’ve ever been before and make all the best choices for the people you love. You can begin by calling our office today to schedule a Family Wealth Planning Session and mention this article to find out how to get this $750 session at no charge.